Listen to the World Bank logic

Updated: 2012-03-02 10:23

By Wu Jiangang (China Daily European Weekly)

Report is an opportunity for China to reassess its economic reform roadmap

This week, a report, titled China 2030: Building a Modern, Harmonious, and Creative High-Income Society, has attracted widespread attention.

While many issues mentioned in the report have been widely discussed in the Chinese media, among the six strategic directions it provides, the most controversial one is the first that suggests China should strengthen the foundations for a market-based economy by redefining the role of government, reforming and restructuring State-owned enterprises and banks, developing the private sector, promoting competition, and deepening reforms in the land, labor and financial markets.

The suggested reforms for a market-based economy, although carefully structured, are consistent with the Washington Consensus, which describes a set of 10 relatively specific economic policy prescriptions, that was considered the "standard" reform package for crisis-wracked developing countries.

Since the prescriptions have bad reputations not only in the economic crisis in South America, but also in the former Soviet Union and Southeast Asia, there is no wonder that many are not too sure of its motives. Although the Ministry of Education, Ministry of Health and other ministries gave high marks to the report, the State-owned Assets Supervision and Administration Commission had expressed strong objections. A protester briefly disrupted a news conference by World Bank President Robert Zoellick on Feb 28.

It is obvious that there are different opinions over the bank's recommendation for Beijing to reduce the dominance of the State in industry and promote free markets. Before we discuss China's complicated situation and reach any opinion on the report, let us understand the theoretical logic of the market economy.

Why do we need a market economy?

In short, compared with the planned economy, the market economy is more efficient. Here "efficient" does not mean "to produce more output with less input". Since human demands are limitless and resources are limited, the main aim of an economy is to assign limited resources among various possible applications so as to meet people's needs to the greatest extent. Since a deal should be free and fair, it is a Pareto improvement. So "efficiency" of an economy is metered by people's satisfaction in selling or buying. In a planned economy planners hardly know the satisfaction of people, because the cost of collecting people's satisfaction information is ridiculously high, not to say that the satisfaction information keeps changing. The best way is to let the people freely choose what they need and use the price equilibrium to gauge the supply/demand information. In this way, every single consumer by choosing in what prices he/she will buy or sell will signal his/her satisfaction information.

What is an ideal market economy?

The prerequisite for any successful deal is that the traded private property rights are clearly defined and well protected. An ideal market economy can ensure that the information signaled by individual consumer is real. The information will be real when a deal is free and fair. So the market should be a free and fair market. In addition, a stable money value is essential, too.

What is the role of government in an ideal market economy?

In a market without government, forced deals may happen. Due to the asymmetry of information between buyers and sellers, the items of contract of a deal are often incomplete. What's more, deals between buyers and sellers can have external effects on others. Sometimes, the market does not provide public goods. In these cases, government can play a role. But the government's role is limited to defense and internal security, administering justice, enforcing contracts and rules of the market system and other laws and regulations, correct market imperfections and failures, ensure full employment without inflation, and so on. Since government can also manipulate its authority, government expenses should be transparent and government behavior should be well limited and supervised by law.

What is the role of State-owned enterprises in an ideal market economy?

State-owned enterprises are set up to deal with market failures, but they are not the only choices, and often not the best one. Take natural monopoly as an example. Although State enterprises can deduct regulatory costs, it causes efficiency loss among the staff who have varied interests. State-owned enterprises do not have much incentive to improve technology and reduce costs.

By using the above theoretic logic to analyze China's economy we can make two important conclusions. The first is that there is no miracle or a "growth model of China" and it is the market that greatly stimulates economic growth.

It is widely regarded as a miracle that China's GDP has grown annually about 10 percent a year from 1978 to 2010 after its reform and opening-up in 1978. Many people think there is a "growth model of China" that can be learned by other countries. In fact, there are no miracles or "growth model of China" and China's GDP growth only reflects the long-term transition from a planned economy to a market economy, which in turn helped increase efficiency.

China has a large population of cheap and diligent labor. They build cities' buildings and national infrastructure and also exports. These buildings, infrastructure and exports can greatly increase GDP. Application of technology and institutions of modern organizations are not widely used in China. As factors of production, the wide use of technology and new institutions can easily increase GDP.

The high deposit rates can provide capital for new projects. Lands can also be used more efficiently. The high GDP increases are achieved through the sacrifice of human capital growth and pollution of the environment.

The other conclusion is that an incorrect role of government can cause damage to the economy. The government should be a judge and public goods provider. As a judge, it should provide institutions, but government still regards itself as player and widely intervenes in the economy. As a public goods provider, government should create a welfare system, but such a system in China is still in the beginning stages.

China's economy is mainly driven by exports, private investments and government investments. Now it seems that consumption cannot increase so fast, and exports and investments will decrease very fast.

The low efficiency of State-owned enterprises has led to a huge increase in bad loans. When some State-owned enterprises become big, they learn to use their monopoly to gain more money without paying any dividend.

Government actions have also led to housing bubbles and mounting local government debts, as many government invested projects including infrastructure, due to lack of use, cannot generate enough cash flow.

Private enterprises, despite being cornered by the monopoly of State-owned enterprises and super-national treatment of foreign-funded enterprises, are fighting for their survival. They just use 30 percent of resources, contributing to 70 percent of innovation and employment. They are the main source of entrepreneurship. But now many of them find that their businesses are facing bleak prospects.

Behind the miracle of GDP increase, the truth is that Chinese are still poor in terms of per capita GDP, as many social risks have been accumulated. China is plagued by an ageing population, high housing prices, high logistics costs, severe pollution, cornered private enterprises, high public debts, inadequate social security system, and the great gap between rich and poor.

The World Bank report believes that after more than 30 years of rapid growth, China has reached another turning point in its development path and an unchanged growth pattern could lead to many risks. The report claims that it provides not only "what" but also "how". After so many examples of countries falling in the middle-income country trap, the first reaction to the report should not be negative, but to rather listen carefully to the logic with a sense of crisis in our mind. After all, we have already had enough lessons in history.

The World Bank report actually gives us a chance to discuss some basic questions of China's economic reform. We need more voices and more discussions - after all it is we who finally decide the details of reform.

The author is a research fellow of the CEIBS Lujiazui International Finance Research Center.